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For so many of us, our home is our biggest asset and, sometimes, our only significant asset. But with home prices rising in many areas of the country, including the extremely popular San Francisco Bay Area, the equity of homeowners is also going up. If you need some extra cash, you might think about taking out a second mortgage or a line of credit. Although these two types of secured loans have similarities, there are some differences to consider.

Tip

Interest on second mortgages is tax deductible. Under the new Tax Cuts and Jobs Act of 2017, HELOC interest can only be deducted if the funds are used to buy, build or improve the property that is securing the loan. All other uses are not tax deductible. Keep receipts.

Borrowing on Equity

Most buyers take out a loan to buy a home, especially their first home. It's pretty rare that young people have sufficient personal funds to pay cash for a house in areas like San Francisco, where the average home price is more than a million dollars. That initial loan used to buy a house is called a mortgage, or first mortgage, and, as a borrower, you agree to pay it off plus interest, typically in monthly installments for 15 or 30 years. The mortgage is a security instrument, giving the lender a lien – the right to take and sell the property if you don't keep up with your payments.

When you buy at market rate, your only equity in the property is your down payment. But soon equity starts to build. Equity refers to the amount your house is worth on the open market minus your mortgage secured by the property. Let's say you found a great deal in San Francisco for "only" $650,000, put $50,000 down and took a loan for the rest. Your starting equity would be around $50,000. But 10 years later, the house is worth $1 million dollars. Your equity is now much greater, as it's the difference between the $1 million fair market value and your outstanding first mortgage balance.

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You can tap into that equity if you want. Lenders make second mortgages or approve lines of credit based on the equity in your property. You may want to speak with a professional to figure out whether this is a good idea and which would work better for you, including tax consequences.

Mortgage versus Line of Credit

If you decide to tap into your equity with a mortgage, it is known as a second mortgage. The first mortgage is always the one used to purchase a property. A second mortgage is a loan for an additional amount and is also secured by your home. You ask for an amount, say $50,000, and get it all up front when you agree to an interest rate and sign a security interest with the bank. Like with a first mortgage, you can find second mortgages that have a fixed rate (you pay the same interest rate and thus have the same monthly payment for the life of the loan) and a 15- or 30-year term.

Lines of credit, also known as HELOCs (home equity lines of credit) operate more like credit cards. You and the lender agree to a maximum you can borrow, an interest rate on the loan and a term during which you can borrow it. The term often ranges from five years to 25 years. As you need money, you access the line of credit and the debt is secured by your home. You often pay only interest on the amount you borrow, and then repay the principal in a balloon payment at the end of the term. The interest rate is variable and usually higher than the rate you can get for a mortgage. But the HELOC offers more flexibility. If you intend to borrow money, repay it, then borrow again, a HELOC allows you to do this.

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About the Author

From Alaska to California, from France's Basque Country to Mexico's Pacific Coast, Teo Spengler has dug the soil, planted seeds and helped trees, flowers and veggies thrive. A professional writer and consummate gardener, Spengler has written about home and garden for Gardening Know How, San Francisco Chronicle, Gardening Guide and Go Banking Rates. She earned a BA from U.C. Santa Cruz, a law degree from U.C. Berkeley's Boalt Hall, and an MA and MFA from San Francisco State. She currently divides her life between San Francisco and southwestern France.